Value investing is one of the most popular investing strategy that made Warren Buffett, the 2nd richest man in the world. He owes it to his teacher, Ben Graham. I'm making this post to differentiate the evolution of the value investing and how it can help you in your portfolio.
The first value investor is good 'ol Ben Graham. He is the father of value investing and wrote 2 popular books "The Intelligent Investor" and "Securities Analysis". They have been the bible of value investors eversince. The idea of Ben Graham is to buy companies that are selling for a really cheap price relative to their intrinsic values. Ben Graham often called it "cigar butts" because you are hunting bargain stocks that have a little bit of value inside them, but if were sold, you can make a decent profit. Later in his life, Ben Graham released a simple formula for picking stocks. Saying that he wants to make investing more simple that ever rather than scrutinizing each annual reports of each companies, he based his criteria more on the P/E. The lesser the P/E the better. But this formula did not made it to the limelight because its as if he was ignoring the first 2 previous books about valuing a company. He made it so simple that the first 2 books became almost obsolete. The formula was then added to the later revised edition of his books. In which our third value investor took, implement, tested, optimized, gave it a new twist and called it his own.
Warren Buffett, upon reading Ben Graham's books decided to become his student and worked for Mr. Ben Graham. He became one of his successful students as proof of what he is today. But his style changed when he realized that it takes too much effort to find bargain prices and sell them to make a profit and he becomes infamous to the people working in the company that he sold. Warren Buffett's style during his early years is to hunt cheap stocks like Ben Graham and sell the companies for profit. The employees in these companies were sacked as the selling completes. So he became unpopular with the locals. Warren Buffett realized this and added a criteria in selecting his stocks. "Cheap price is good. But a good business at a cheap price is better." So he went on and search for companies that are good and stable businesses with competitive advantage. This is how he made his billions.
Comes the third value investor whose book I just read, Joel Greenblatt. I'm still not sure if he should be ranked amongst the great Ben Graham and Warren Buffett, but his value investing is simple that combined the 2 principles of Graham and Buffett plus adding his own style of using quantitative analysis to compare all the stocks into a simple formula. He says to look for stocks that are selling cheap and stocks that have good businesses behind them. He is looking for businesses that has high return on invested capital this is a criteria from Buffett, competitive advantage, but Greenblatt wants to have a mathematical description of it not qualitative as Buffett analyze it. Greenblatt wants it to be in numbers. And then he also looks for businesses that are selling cheap buy looking at its EBIT or Earnings Before Interest and Taxes over its Enterprise Value, Graham's style. The idea behind his formula is you want to know the real value of the businesses should you really buy the business in real life. Giving you a clearer picture of the value of the business. What's good about Greenblatt is he made it into a systematic approach without any decision making involved, you can even plot its formula in an excel file and watch the computer spit out the stocks that meet his criteria. Performance wise, it holds true. Graham, Buffett and Greenblatt all beat the market or performs better than the indices over a long period of time.
If its so great why isn't everyone using it? The reason behind that is simple. Eventhough Ben Graham made his principle public years and years ago, thinking that all people will be using his approach and thus making the strategy obsolete, it is still applicable today. Its because the style of these guys do not work for short term periods. It would take 2 - 3 years before you beat the market and most people can't stomach that kind of strategy so they go on and day trade. But over the long period of time, it is the easiest and most effective way to invest your money.
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